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**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

** **

**FORM 10-Q**

** **
| **x** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For thequarterly period ended September 30, 2009.**

** **

**OR**

 
| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
|-------|----------------------------------------------------------------------------------------------------------|

 

**For thetransition period from                  to                  **

 

**Commission File Number: 1-11388**

 

**PLCSYSTEMS INC.**

(Exact Name ofRegistrant as Specified in Its Charter)

 

| **Yukon Territory, Canada**                | ** ** | **04-3153858**                        |
|--------------------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction of           |       | (I.R.S. Employer  Identification No.) |
| Incorporation or  Organization)            |       |                                  |
|                                       |       |                                  |
| **10 Forge Park, Franklin, Massachusetts** | ** ** | **02038**                             |
| (Address of  Principal Executive Offices)  |       | (Zip Code)                            |

 

Registrant’s telephone number, including area code: **(508) 541-8800**

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  **Yes ****x****  No ****o**

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). **Yes ****o****  No ****o**

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large accelerated  filer o                |   | Accelerated filer o          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer o                  |   | Smaller reporting  company x |
| (Do not check if a smaller  reporting company) |   |                              |

 

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Exchange Act)  **Yes ****o****  No ****x**

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

| **Class**                  | ** ** | **Outstanding  at November 9, 2009** |
|----------------------------|------------|-------------------------------------------|
| Common Stock, no par value |       | 30,351,092                                |

 

 

 

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**PLCSYSTEMS INC.**

 

**Index**

 
| Part I.  | Financial Information: |                                                                                        |   |
|---------------|------------------------|---------------------------------------------------------------------------------------------|--------|
|          |                   |                                                                                        |   |
|          | Item 1.                | Financial Statements                                                                        |   |   |
|          |                   |                                                                                        |   |   |
|          |                   | Condensed  Consolidated Balance Sheets (unaudited)                                          |   | 3 |
|          |                   |                                                                                        |   |   |
|          |                   | Condensed  Consolidated Statements of Operations (unaudited)                                |   | 4 |
|          |                   |                                                                                        |   |   |
|          |                   | Condensed  Consolidated Statements of Cash Flows (unaudited)                                |   | 5 |
|          |                   |                                                                                        |   |   |
|          |                   | Notes to Condensed Consolidated Financial Statements  (unaudited)                           |   | 6 |
|          |                   |                                                                                        |   |   |
|          | Item 2.                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   | 13 |
|          |                   |                                                                                        |   |   |
|          | Item 3.                | Quantitative  and Qualitative Disclosures about Market Risk                                 |   | 21 |
|          |                   |                                                                                        |   |   |
|          | Item 4T.               | Controls and  Procedures                                                                    |   | 21 |
|          |                   |                                                                                        |   |   |
| Part II. | Other Information:     |                                                                                        |   |
|          |                   |                                                                                        |   |   |
|          | Item 1A.               | Risk Factors                                                                                |   | 22 |
|          |                   |                                                                                        |   |   |
|          | Item 6.                | Exhibits                                                                                    |   | 22 |

 

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**Part I.    Financial Information**

 

**Item 1.        FinancialStatements**

 

**PLCSYSTEMS INC.**

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

 
| ** **                                                                                                                                               | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                               | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                          |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                |       | $                            | 3,252      |                        | $          | 5,026 |   |
| Accounts receivable, net of allowance of $26 and $20  at September 30, 2009 and December 31, 2008, respectively                                |       | 924                          |       | 802                         |       |
| Inventories, net                                                                                                                                         |       | 945                          |       | 1,136                       |       |
| Prepaid expenses and other current assets                                                                                                                |       | 527                          |       | 598                         |       |
| Total current assets                                                                                                                                     |       | 5,648                        |       | 7,562                       |       |
| Equipment, furniture and leasehold improvements, net                                                                                                     |       | 88                           |       | 160                         |       |
| Other assets                                                                                                                                             |       | 188                          |       | 191                         |       |
| Total assets                                                                                                                                             |       | $                            | 5,924      |                        | $          | 7,913 |   |
|                                                                                                                                                     |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                            |       |                         |       |                        |       |
| Current liabilities:                                                                                                                                     |       |                         |       |                        |       |
| Accounts payable                                                                                                                                         |       | $                            | 169        |                        | $          | 296 |   |
| Accrued compensation                                                                                                                                     |       | 342                          |       | 525                         |       |
| Accrued other                                                                                                                                            |       | 236                          |       | 138                         |       |
| Deferred revenue                                                                                                                                         |       | 2,194                        |       | 2,405                       |       |
| Total current liabilities                                                                                                                                |       | 2,941                        |       | 3,364                       |       |
| Deferred revenue                                                                                                                                         |       | 681                          |       | 1,358                       |       |
| Stockholders’ equity:                                                                                                                               |       |                         |       |                        |       |
| Preferred  stock, no par value, unlimited shares authorized, none issued and outstanding                                                                 |       | —                       |       | —                      |       |
| Common  stock, no par value, unlimited shares authorized, 30,351 shares issued and  outstanding as of September 30, 2009 and December 31, 2008 |       | 93,893                       |       | 93,893                      |       |
| Additional paid in capital                                                                                                                               |       | 595                          |       | 474                         |       |
| Accumulated deficit                                                                                                                                      |       | (91,861                      | )          | (90,838                     | )          |
| Accumulated other comprehensive loss                                                                                                                     |       | (325                         | )          | (338                        | )          |
| Total stockholders’ equity                                                                                                                          |       | 2,302                        |       | 3,191                       |       |
| Total liabilities and stockholders’ equity                                                                                                          |       | $                            | 5,924      |                        | $          | 7,913 |   |

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

 

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**PLCSYSTEMS INC.**

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands,except per share data)

(Unaudited)

 
| ** **                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                            | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                             |       |                                       |       |                                      |       |   |   |   |   |
| Product sales                         |       | $                                          | 701        |                                      | $          | 1,203 |   | $ | 2,824 |   | $ | 3,041 |   |
| Service fees                          |       | 322                                        |       | 395                                       |       | 986 |   | 1,035 |   |
| Total revenues                        |       | 1,023                                      |       | 1,598                                     |       | 3,810 |   | 4,076 |   |
| Cost of revenues:                     |       |                                       |       |                                      |       |   |   |   |   |
| Product sales                         |       | 311                                        |       | 647                                       |       | 1,059 |   | 1,290 |   |
| Service fees                          |       | 189                                        |       | 182                                       |       | 516 |   | 517 |   |
| Total cost of revenues                |       | 500                                        |       | 829                                       |       | 1,575 |   | 1,807 |   |
| Gross profit                          |       | 523                                        |       | 769                                       |       | 2,235 |   | 2,269 |   |
| Operating expenses:                   |       |                                       |       |                                      |       |   |   |   |   |
| Selling, general and  administrative  |       | 702                                        |       | 619                                       |       | 2,667 |   | 2,420 |   |
| Research and development              |       | 180                                        |       | 516                                       |       | 594 |   | 1,726 |   |
| Total operating expenses              |       | 882                                        |       | 1,135                                     |       | 3,261 |   | 4,146 |   |
| Loss from operations                  |       | (359                                       | )          | (366                                      | )          | (1,026 | ) | (1,877 | ) |
| Other income, net                     |       | 1                                          |       | 11                                        |       | 3 |   | 89 |   |
| Loss before taxes                     |       | (358                                       | )          | (355                                      | )          | (1,023 | ) | (1,788 | ) |
| Benefit from income taxes             |       | —                                     |       | (70                                       | )          | — |   | (70 | ) |
| Net loss                              |       | $                                          | (358       | )                                         | $          | (285 | ) | $ | (1,023 | ) | $ | (1,718 | ) |
| Basic and diluted loss per  share     |       | $                                          | (0.01      | )                                         | $          | (0.01 | ) | $ | (0.03 | ) | $ | (0.06 | ) |
| Weighted average shares  outstanding: |       |                                       |       |                                      |       |   |   |   |   |
| Basic and diluted                     |       | 30,351                                     |       | 30,332                                    |       | 30,351 |   | 30,331 |   |

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

 

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**PLC SYSTEMS INC.**

CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 
| ** **                                                                    | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                    | ** ** | **2009**                                  | ** ** | **2008** | ** ** |
| Operating activities:                                                         |       |                                      |       |   |   |
| Net loss                                                                      |       | $                                         | (1,023     | ) | $ | (1,718 | ) |
|                                                                          |       |                                      |       |   |   |
| Adjustments to reconcile net loss to net cash used  for operating activities: |       |                                      |       |   |   |
| Depreciation and amortization                                                 |       | 75                                        |       | 79 |   |
| Compensation expense from stock options                                       |       | 121                                       |       | 151 |   |
| Loss on retirement of equipment                                               |       | —                                    |       | 35 |   |
| Change in assets and liabilities:                                             |       |                                      |       |   |   |
| Accounts receivable                                                           |       | (149                                      | )          | 124 |   |
| Inventory                                                                     |       | 191                                       |       | (292 | ) |
| Prepaid expenses and other assets                                             |       | 71                                        |       | 256 |   |
| Accounts payable                                                              |       | (128                                      | )          | (300 | ) |
| Deferred revenue                                                              |       | (890                                      | )          | (533 | ) |
| Accrued liabilities                                                           |       | (85                                       | )          | (292 | ) |
| Net cash used for operating activities                                        |       | (1,817                                    | )          | (2,490 | ) |
|                                                                          |       |                                      |       |   |   |
| Investing activities:                                                         |       |                                      |       |   |   |
| Purchase of equipment                                                         |       | —                                    |       | (27 | ) |
|                                                                          |       |                                      |       |   |   |
| Financing Activities:                                                         |       |                                      |       |   |   |
| Net proceeds from issuance of common stock                                    |       | —                                    |       | 1 |   |
|                                                                          |       |                                      |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                 |       | 43                                        |       | (7 | ) |
| Net decrease in cash and cash equivalents                                     |       | (1,774                                    | )          | (2,523 | ) |
| Cash and cash equivalents at beginning of period                              |       | 5,026                                     |       | 8,060 |   |
| Cash and cash equivalents at end of period                                    |       | $                                         | 3,252      |   | $ | 5,537 |   |

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

 

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**PLCSYSTEMS INC.**

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30,2009

 

***1.******                                     ******Business***

 

PLC Systems Inc. (“PLC” or the “Company”)is a medical device company specializing in innovative technologies for thecardiac and vascular markets.  TheCompany pioneered and manufactures the *CO**2** Heart Laser System* (the “Heart Laser System”) that cardiacsurgeons use to perform carbon dioxide (CO2) transmyocardial revascularization, orTMR, to alleviate symptoms of severe angina. The Company also manufactures CO2 surgical laser tubes and provides contractassembly services on general purpose CO2**lasers,which it sells to a single customer on an original equipment manufacturer (“OEM”)basis.

 

On March 20, 2007, the Companyentered into a distribution agreement with Novadaq Corp. (“Novadaq”), asubsidiary of Novadaq Technologies Inc., pursuant to which the Companyappointed Novadaq as its exclusive distributor in the United States for its TMRbusiness.  The agreement amended andrestated the exclusive distribution agreement between the Company and EdwardsLifesciences LLC (“Edwards”), which had been assigned by Edwards to Novadaq onthe same date.  The agreement with Novadaqreflects substantially the same roles, responsibilities and financial terms asthe previous agreement with Edwards.

 

In addition, the Company has beguninitial commercialization, primarily in the European Union (“EU”), of itsnewest product, RenalGuard®. RenalGuard is designed to reduce thepotentially toxic effects that contrast media can have on the kidneys when itis administered to patients during certain medical imaging procedures. It isbelieved that allowing contrast media to dwell in the kidneys can lead tocontrast-induced nephropathy (“CIN”), a potentially deadly form of acute kidneyinjury. By inducing and maintaining a high urine flow rate before, during andafter these medical imaging procedures, the Company believes the incidencerates of CIN in at-risk patients can be reduced. RenalGuard facilitates thisincreased urine clearance, enabling the body to more rapidly void the contrastmedia, thereby reducing its overall resident time and toxic effects in thekidney.

 

The Company has received full U.S. Foodand Drug Administration (“FDA”) approval to conduct a pivotal human clinicaltrial of RenalGuard evaluating its safety and effectiveness in preventingCIN.  This trial is required to support apre-market approval application which must be approved by the FDA before theCompany can market RenalGuard in the U.S. The Company does not intend tocommence this pivotal study until it is able to secure sufficient additionalcapital to complete the study.

 

The Company is supporting aninvestigator-sponsored randomized controlled trial utilizing RenalGuard that isbeing conducted at the Centro Cardiologico Monzino-University of Milan (“CCM”)in Milan, Italy. The CCM trial is designed to determine the effectiveness ofRenalGuard in preventing CIN in at-risk patients.  The Company hopes that the data from the CCMclinical trial will enable it to raise the additional capital necessary to bothstart and complete the U.S. pivotal study. Another investigator-sponsored clinical trial of RenalGuard is also ongoingat the Clinica Medeterranea in Naples, Italy.

 

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RenalGuard is currently approved for salein the EU as a general fluid balancing device. The RenalGuard SystemTM consists of a proprietary, closed loop,software-controlled console and accompanying single-use sets that can be usedby physicians and nurses to manage patient fluid levels.  RenalGuard operates by first collecting andmeasuring patient urine outputs and then, in real-time, precisely matchingthose urine outputs with a prescribed replacement fluid by means of intravenousinfusion. With its automated matched fluid replacement capability, RenalGuard isintended to minimize the risk to patients of over- or under-hydration whilealso eliminating to a large degree what can otherwise be an intensive andtime-consuming manual fluid balancing task for physicians and nurses.

 

The Company is currently establishing adistribution network outside the U.S. with the intent to market RenalGuard forgeneral fluid balancing applications.

 

***2.******                                     ******Basis of Presentation***

 

The accompanyingunaudited condensed consolidated financial statements of the Company have beenprepared in accordance with generally accepted accounting principles (“GAAP”)for interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included. Operatingresults for the three and nine months ended September 30, 2009 are notnecessarily indicative of the results that may be expected for the year ending December 31,2009.  These financial statements shouldbe read in conjunction with the consolidated financial statements and footnotesthereto included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2008.

 

Thepreparation of financial statements in accordance with generally acceptedaccounting principles requires the Company to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements, andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

***3.******                                     ******Inventories***

 

Inventories are stated at the lower of cost (computed on a first-in,first-out method) or market value and include allocations of labor andoverhead.  As of September 30, 2009and December 31, 2008, inventories consisted of the following (inthousands):

 
| ** **        | ** ** | **September 30,********2009** | ** ** | **December 31,********2008** | ** ** |
|-------------------|------------|------------------------------------|------------|-----------------------------------|------------|
| Raw  materials    |       | $                                  | 345        |                              | $          | 573 |   |
| Work  in progress |       | 22                                 |       | 154                               |       |
| Finished  goods   |       | 578                                |       | 409                               |       |
|              |       | $                                  | 945        |                              | $          | 1,136 |   |

 

At September 30, 2009 and December 31, 2008, inventories arestated net of a specific obsolescence allowance of $800,000 and $808,000,respectively.

 

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***4.******                                     ******Stock-BasedCompensation***

 

In May 2005, the Company’sshareholders approved the 2005 Stock Incentive Plan (the “2005 Plan”).  Incentive stock options are issuable only toemployees of the Company, while non-qualified stock options may be issued tonon-employee directors, consultants and others, as well as to employees.  Under the 2005 Plan, the per share exerciseprice of incentive stock options may not be less than the fair market value ofthe common stock on the date the option is granted.  The 2005 Plan provides that the Company maynot grant non-qualified stock options at an exercise price less than 85% of thefair market value of the Company’s common stock.

 

The Company grants stock options to itsnon-employee directors.  New non-employeedirectors receive an initial grant of an option to purchase 45,000 shares ofthe Company’s common stock that generally vests in quarterly installments overthree years.  Once the initial grant hasfully vested, non-employee directors (other than the Chairman of the Board)receive an annual grant of an option to purchase 15,000 shares of the Company’scommon stock that generally vests in four equal quarterly installments. TheChairman of the Board receives an annual grant of an option to purchase 30,000shares of the Company’s common stock that generally vests in four equalquarterly installments. All such options have an exercise price equal to thefair market value of the Company’s common stock on the date of grant.

 

On April 21, 2009, the Board ofDirectors approved an option exchange program pursuant to which employees anddirectors at the time were offered the opportunity to exchange outstandingoptions to purchase shares of common stock of the Company that had an exerciseprice of $0.30 or greater per share for new options to purchase shares ofcommon stock. The exchange offer commenced on April 22, 2009 and expiredon May 19, 2009.

 

Pursuant to the exchange offer, optionsto purchase a total of 5,175,000 shares of common stock with exercise pricesranging from $0.37 to $2.78 per share were canceled in exchange for options topurchase 5,175,000 shares of common stock at an exercise price of $0.24 pershare.  The exchange offer resulted in anincremental compensation charge of $170,000 to be recognized over the vestingperiod of the new option grants. All options tendered under the exchangeprogram, which were previously granted to employees and directors under theCompany’s 1993 Stock Option Plan, 1995 Stock Option Plan, 1997 Executive StockOption Plan, 2000 Equity Incentive Plan, 2000 Non-Statutory Stock Option Plan,2000 Non-Qualified Performance and Retention Equity Plan and the 2005 Plan,were replaced with new options granted under the 2005 Plan.  Options granted to employees pursuant to theoption exchange program vest one-third on the one-year anniversary of the newoption grant and an additional one-twelfth for each successive three monthperiod following the one-year anniversary of the new option grant and expirefive years from the date of grant. Options granted to non-employee directors pursuant to the optionexchange program vest ratably quarterly over a one year period and expire fiveyears from the date of grant. In addition, other options to purchase a total of75,000 shares were granted to certain directors in 2009.  These options vest ratably quarterly over aone year period and expire five years from the date of grant or they vestratably quarterly over a three year period and expire ten years from the dateof grant.  As of September 30, 2009,there were 999,000 shares of common stock available to be granted under the2005 Plan.

 

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The following is a summary of option activity underall plans (in thousands, except per option data):

 
| ** **                            | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Average  Remaining  Contractual  Life (Years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|---------------------------------------------------|------------|---------------------------------|------------|
| Outstanding,  December 31, 2008  |       | 5,499                   |       | $                                      | 0.69       |                                              | 5.43       |                            |       |   |
| Granted                               |       | 5,250                   |       | 0.24                                   |       |                                              |       |                            |       |
| Exercised                             |       | —                  |       | —                                 |       |                                              |       |                            |       |
| Forfeited                             |       | (183                    | )          | 0.86                                   |       |                                              |       |                            |       |
| Expired                               |       | (81                     | )          | 2.38                                   |       |                                              |       |                            |       |
| Canceled                              |       | (5,175                  | )          | 0.65                                   |       |                                              |       |                            |       |
| Outstanding,  September 30, 2009 |       | 5,310                   |       | $                                      | 0.25       |                                              | 4.70       |                            | $          | 311 |   |
| Exercisable,  September 30, 2009 |       | 242                     |       | $                                      | 0.41       |                                              | 4.14       |                            | $          | 12 |   |

 

The aggregate fair value of shares vested during thenine months ended September 30, 2009 was $110,000.

 

The following table summarizes unvested optionactivity during the nine months ended September 30, 2009:

 
| ** **                        | ** ** | **Number  of  Options**                          | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                        | ** ** | **(In thousands, except weighted average data)** | ** ** |
| Unvested, December 31, 2008  |       | 968                                              |       | $                                                       | 0.35       |   |
| Granted                           |       | 5,250                                            |       | 0.18                                                    |       |
| Vested                            |       | (368                                             | )          | 0.30                                                    |       |
| Forfeited/Expired/Canceled        |       | (782                                             | )          | 0.34                                                    |       |
| Unvested, September 30, 2009 |       | 5,068                                            |       | 0.18                                                    |       |
|                                   |            |                                                  |            |                                                         |            |  |

 

*Stock-Based Compensation Expense*

 

The Company estimates thefair value of stock options on the day of grant using the Black-Scholes optionpricing model, which incorporates various assumptions including volatility,expected life and interest rates.  The Company recorded compensation expense of$54,000 and $121,000 in the three and nine months ended September 30,2009, respectively, as compared to $54,000 and $151,000 in the three and ninemonths ended September 30, 2008, respectively.  As of September 30, 2009, the Companyhad $273,000 of total unrecognized compensation cost related to its unvestedoptions, which is expected to be recognized over a weighted average period of2.3 years.

 

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Theweighted average fair value of options issued during the three and nine monthsended September 30, 2009 was estimated using the Black-Scholes model.

 
| ** **              | ** ** | **Three and Nine Months Ended  September 30, 2009** | ** ** |
|-------------------------|------------|----------------------------------------------------------|------------|
| Expected life (years)   |       | 1.00-5.50                                                |       |
| Interest rate           |       | 0.47%-2.75%                                              |       |
| Volatility              |       | 103.1%-205.2%                                            |       |
| Expected dividend yield |       | None                                                     |       |
| Value of option granted |       | $0.13-$0.23                                              |       |

 

The expected life wascalculated in 2009 and 2008 using the simplified method. The risk-free interestrate is based on the U.S. Treasury yield curve in effect at the time of thegrant for the expected term period. Expected volatility is based exclusively on historical volatility dataof the Company’s common stock.  TheCompany estimates an expected forfeiture rate based on its historicalforfeiture activity.  Actual results, andfuture changes in estimates, may differ substantially from the Company’scurrent estimates.

 

*Stock Purchase Plan*

 

TheCompany has a 2000 Employee Stock Purchase Plan (the “Purchase Plan”) for alleligible employees whereby shares of the Company’s common stock may bepurchased at six-month intervals at 95% of the closing stock price on the lastbusiness day of the relevant plan period. The Company’s stock trades in the over-the-counter market and, as such,the last sale price of the Company’s stock is deemed to be the closing stockprice for purposes of determining the purchase price for the current six-monthperiod.  Employees may purchase shareshaving a value not exceeding 10% of their gross compensation during an offeringperiod, subject to certain additional limitations.  Under the Purchase Plan, employees of theCompany purchased 21,612 shares of common stock in 2008 at an average price of $0.08per share.  There was no purchase activityin the nine months ended September 30, 2009.  At September 30, 2009, 294,461 shareswere reserved for future issuance under the Purchase Plan.

 

***5.******                                     ******Revenue Recognition***

 

TheCompany records revenue from the sale of TMR kits at the time of shipment toNovadaq.  TMR kit revenues include theamount invoiced to Novadaq for kits shipped pursuant to purchase ordersreceived, as well as an amortized portion of deferred revenue related to apayment of $4,533,333 from Edwards, the Company’s previous exclusive U.S. TMRdistributor, received in February 2004. This payment was made in exchange for a reduction in the prospectivepurchase price the Company receives upon a sale of the kits.  The Company is amortizing this payment intoits Consolidated Statements of Operations as revenue over a seven year period(culminating in 2010).  The Companydetermined that a seven year timeframe was the most appropriate amortizationperiod based on a valuation model it used to assess the economic fairness ofthe payment. Factors the Company considered in developing this valuation modelincluded the estimated foregone revenues over a seven year period resultingfrom the reduction in the prospective purchase price payable to the Company, adiscount rate deemed appropriate to this transaction and an estimate of theremaining economic useful life of the current TMR kit design, without anybenefit being given to potential future product

 

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improvements the Company may make. The Company reviews annually, and adjusts if necessary, the prospectiverevenue amortization rate for kits based on its best estimate of the totalnumber of kits likely remaining to be shipped to hospital customers by Novadaqthrough 2010. The Company recorded amortization of $176,000 and $621,000 in thethree and nine months ended September 30, 2009, respectively, as comparedto $191,000 and $539,000 in the three and nine months ended September 30,2008, respectively, which is included in revenues in the ConsolidatedStatements of Operations.

 

TMRlasers are billed to Novadaq in accordance with purchase orders that theCompany receives.  Invoiced TMR lasersare recorded as other current assets and deferred revenue on the Company’sConsolidated Balance Sheet until such time as the laser is shipped to ahospital, at which time the Company records revenue and cost of revenue.

 

Under theterms of the Novadaq TMR distribution agreement, once Novadaq has recovered aprescribed amount of revenue from a hospital for the use or purchase of a TMRlaser, any additional revenues earned by Novadaq are shared with the Companypursuant to a formula established in the distribution agreement. The Companyonly records its share of such additional revenue, if any, at the time therevenue is earned.

 

The Company records allother product revenue, including sales of TMR lasers and kits to international customers,sales of RenalGuard consoles and single-use sets and OEM sales of surgicaltubes and general purpose CO2 lasers, at the time of shipment.

 

Revenues from service andmaintenance contracts are recognized ratably over the life of the contract.

 

Installation revenuesrelated to a TMR laser transaction are recorded as a component of service feeswhen the laser is installed.

 

***6.             Loss perShare***

 

In thethree and nine months ended September 30, 2009 and 2008, basic and dilutedloss per share have been computed using only the weighted average number ofcommon shares outstanding during the period without giving effect to anypotential future issuances of common stock related to stock option programs,since their inclusion would be antidilutive.

 

Forthe three months ended September 30, 2009 and 2008, 5,310,000 and5,501,000 shares, respectively, and for the nine months endedSeptember 30, 2009 and 2008, 5,310,000 and 5,501,000 shares, respectively,attributable to outstanding stock options were excluded from the calculation ofdiluted earnings per share because the effect would have beenantidilutive.  The following table setsforth the computation of basic and diluted loss per share:

 

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| ** **                           | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2009**                                    | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                           | ** ** | **(In  thousands, except per share data)**  | ** ** |
| Basic:                               |       |                                        |       |                                       |       |   |   |   |   |
| Net  loss                            |       | $                                           | (358       | )                                          | $          | (285 | ) | $ | (1,023 | ) | $ | (1,718 | ) |
| Weighted  average shares outstanding |       | 30,351                                      |       | 30,332                                     |       | 30,351 |   | 30,331 |   |
| Basic  and diluted loss per share    |       | $                                           | (0.01      | )                                          | $          | (0.01 | ) | $ | (0.03 | ) | $ | (0.06 | ) |

 

***7.             ComprehensiveLoss***

 

Totalcomprehensive loss for the three and nine months ended September 30, 2009amounted to $353,000 and $1,010,000, respectively, as compared to $293,000 and$1,724,000 in the three and nine months ended September 30, 2008,respectively.  Comprehensive loss is comprisedof net loss plus the increase/decrease in currency translation adjustment.

 

***8.             Warranty andPreventative Maintenance Costs***

** **

TheCompany warranties its products against manufacturing defects under normal useand service during the warranty period. The Company obtains similar warranties from a majority of its suppliers,including those who supply critical Heart Laser System components.  In addition, under the terms of its TMRdistribution agreement with Novadaq, the Company is able to bill Novadaq foractual warranty costs, including preventative maintenance services, up to aspecified amount during the warranty period.

 

TheCompany evaluates the estimated future unrecoverable costs of warranty andpreventative maintenance services for its installed base of lasers andRenalGuard consoles and single-use sets on a quarterly basis and adjusts itswarranty reserve accordingly.  TheCompany considers all available evidence, including historical experience andinformation obtained from supplier audits.

 

Changesin the warranty accrual were as follows (in thousands):

 
| ** **                          | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                    | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Balance,  beginning of period       |       | $                                           | 20         |                                       | $          | 10 |   | $ | 10 |   | $ | 60 |   |
| Change  in liability for warranties |       | (12                                         | )          | —                                     |       | (2 | ) | (50 | ) |
| Balance,  end of period             |       | $                                           | 8          |                                       | $          | 10 |   | $ | 8 |   | $ | 10 |   |

 

***9.             NewAccounting Pronouncements***

 

In June 2009, theFinancial Accounting Standards Board (“FASB”) issued the FASB AccountingStandards Codification (“Codification”). The Codification is the single source for all authoritative GAAP and iseffective for financial statements issued for periods ending afterSeptember 15, 2009.  The adoption ofthe Codification only impacts references for accounting 

 

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guidance and does notaffect the Company’s consolidated financial position, results of operations andcash flows.

 

**Item2.****                      ****Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

**Overview**

** **

We are a medical devicecompany specializing in innovative technologies for the cardiac and vascularmarkets.  We pioneered and manufacturethe Heart Laser System that cardiac surgeons use to perform TMR to alleviatesymptoms of severe angina. We also manufacture CO2 surgical laser tubes and provide contractassembly services on general purpose CO2**lasers.

 

In addition, we havebegun initial commercialization, primarily in the EU, of our newest product,RenalGuard. RenalGuard is designed to reduce the potentially toxic effects thatcontrast media can have on the kidneys when it is administered to patientsduring certain medical imaging procedures. It is believed that allowingcontrast media to dwell in the kidneys can lead to CIN, a potentially deadlyform of acute kidney injury. By inducing and maintaining a high urine flow ratebefore, during and after these medical imaging procedures, we believe theincidence rates of CIN in at-risk patients can be reduced. RenalGuardfacilitates this increased urine clearance, enabling the body to more rapidlyvoid the contrast media, thereby reducing its overall resident time and toxiceffects in the kidney.

 

In the U.S., the Companyhas received full FDA approval to conduct a pivotal human clinical trial ofRenalGuard evaluating its safety and effectiveness in preventing CIN.  This trial is required to support apre-market approval application which must be approved by the FDA before theCompany can market RenalGuard in the U.S. The Company does not intend to commencethis pivotal study until it is able to secure sufficient additional capital tocomplete the study.

 

We are currentlysupporting an investigator-sponsored randomized controlled trial utilizingRenalGuard that is being conducted at the CCM in Milan, Italy; it is designedto determine the effectiveness of RenalGuard in preventing CIN in at-riskpatients. We hope that the data from the clinical trial in Italy will enable usto raise the additional capital necessary to both start and complete the U.S.pivotal study.  In addition, we recentlylearned of another investigator-sponsored clinical trial of RenalGuard inNaples, Italy.

 

RenalGuard is currentlyapproved for sale in the EU as a general fluid balancing device. The RenalGuardSystem consists of a proprietary, closed loop, software-controlled console andaccompanying single-use sets that can be used by physicians and nurses tomanage patient fluid levels. RenalGuard operates by first collecting andmeasuring patient urine outputs and then, in real-time, precisely matchingthose urine outputs with a prescribed replacement fluid by means of intravenousinfusion. With its automated matched fluid replacement capability, RenalGuardis intended to minimize the risk to patients of over- or under-hydration while alsoeliminating to a large degree what can otherwise be an intensive andtime-consuming manual fluid balancing task for physicians and nurses.  We are establishing a distribution networkoutside the U.S. with the intent to market RenalGuard for general fluidbalancing applications.

 

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Novadaq,our U.S. distributor for the Heart Laser System, is our largest customer,accounting for 73% and 65% of our total revenues in the three and nine monthsended September 30, 2009, respectively. We expect a high level of sales concentration to continue in the nearfuture with Novadaq as our largest customer because it holds the exclusive U.S.distribution rights for our TMR products.

 

Approximately77% and 76% of our revenues in the three and nine months endedSeptember 30, 2009, respectively, came from the sale and service of TMRlasers and related disposable kits. We believe that the number of opportunitiesfor new TMR laser sales to U.S. hospital customers, and specifically salesopportunities for our HL2 laser, will continue to be limited in future quartersas a result of (1) a diminishing number of available hospitals that havenot already implemented a TMR program that are still likely to do so in thefuture, and (2) continuing financial pressures that hospitals face, inparticular for the funding of new capital equipment purchases, in light of boththe tight global credit markets and the ongoing trend of cutbacks in bothMedicare and private insurance reimbursement rates for a majority of medicalprocedures. In addition, we have seen a recent downward trend in the price atwhich new TMR lasers are being sold in the U.S. market as competition for theremaining available customers increases. As such, we expect that our U.S. TMRrevenues in future quarters will continue to be mostly dependent upon the saleof TMR kits and service revenues.

 

Ourmanagement reviews a number of key performance indicators to assist indetermining how to allocate resources and run our day-to-day operations. Theseindicators include (1) actual prior quarterly sales trends,(2) projected U.S. TMR laser and kit sales for the next four quarters, asprovided by Novadaq in a rolling 12 month sales forecast, (3) projectedfuture sales of OEM surgical tubes and laser assembly services,(4) projected future sales of RenalGuard consoles and single-use sets,(5) research and development progress as measured against internal projectplan objectives, (6) budget to actual financial expenditure results,(7) inventory levels (both our own and our distributors’), and(8) short term and long term projected cash flows of the business.

 

**CriticalAccounting Policies and Estimates**

** **

Ourfinancial statements are based upon the application of significant accountingpolicies, many of which require us to make significant estimates andassumptions (see Note 2 to the Consolidated Financial Statements).  We believe that the following are some of themore material judgment areas in the application of our accounting policies thatcurrently affect our financial condition and results of operations.

 

***Inventories***

** **

Inventoriesare stated at the lower of cost (computed on a first-in, first-out method) ormarket value and include allocations of labor and overhead.  A specific obsolescence allowance is providedfor slow moving, excess and obsolete inventory based on our best estimate ofthe net realizable value of inventory on hand, taking into considerationfactors such as (1) actual trailing 12 month sales, (2) expectedfuture product line demand, based in part upon sales forecast input receivedfrom Novadaq and our other customers, and (3) service part stocking levelswhich, in management’s best judgment, are advisable to maintain in order tomeet warranty, service contract and time and material spare part demands.  Historically, we have found our reserves tobe adequate.

 

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***Accounts Receivable***

 

Accountsreceivable are stated at the amount we expect to collect from the outstandingbalances.  We continuously monitorcollections from customers, and we maintain a provision for estimated creditlosses based upon historical experience and any specific customer collectionissues that we have identified. Historically, we have not experienced significant losses related to ouraccounts receivable. Collateral is not generally required. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances might be required.

 

***Research and Development***

 

Researchand development costs are expensed as incurred.

 

***Warranty and Preventative Maintenance Costs***

** **

Wewarranty our products against manufacturing defects under normal use andservice during the warranty period.  Weobtain similar warranties from a majority of our suppliers, including those whosupply critical Heart Laser System components. In addition, under the terms of our TMR distribution agreement withNovadaq, we are able to bill Novadaq for actual warranty costs, includingpreventative maintenance services, up to a specified amount during the warrantyperiod.

 

Weevaluate the estimated future unrecoverable costs of warranty and preventativemaintenance services for our installed base of lasers and RenalGuard consolesand single-use sets on a quarterly basis and adjust our warranty reserveaccordingly.  We consider all availableevidence, including historical experience and information obtained fromsupplier audits.

 

***Revenue Recognition***

 

Werecord revenue from the sale of TMR kits at the time of shipment toNovadaq.  TMR kit revenues include theamount invoiced to Novadaq for kits shipped pursuant to purchase ordersreceived, as well as an amortized portion of deferred revenue related to apayment of $4,533,333 from Edwards, our previous exclusive U.S. TMRdistributor, received in February 2004. This payment was made in exchange for a reduction in the prospectivepurchase price we receive upon a sale of the kits.  We are amortizing this payment into ourConsolidated Statements of Operations as revenue over a seven year period(culminating in 2010). We determined that a seven year timeframe was the mostappropriate amortization period based upon a valuation model we used to assessthe economic fairness of the payment. Factors we considered in developing thisvaluation model included the estimated foregone revenues over a seven yearperiod resulting from the reduction in the prospective purchase price payableto us, a discount rate deemed appropriate to this transaction and an estimateof the remaining economic useful life of the current TMR kit design, withoutany benefit being given to potential future product improvements we may make.We review annually, and adjust if necessary, the prospective revenueamortization rate for kits based on our best estimate of the total number ofkits likely remaining to be shipped to hospital customers by Novadaq through2010. We recorded amortization of $176,000 and $621,000 in the three and ninemonths ended September 30, 2009, respectively, as compared to $191,000 and$539,000 in the three and nine months ended September 30, 2008,respectively, which is included in revenues in our Consolidated Statements

 

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of Operations.

 

TMRlasers are billed to Novadaq in accordance with purchase orders that wereceive.  Invoiced TMR lasers arerecorded as other current assets and deferred revenue on our ConsolidatedBalance Sheet until such time as the laser is shipped to a hospital, at whichtime we record revenue and cost of revenue.

 

Underthe terms of the TMR distribution agreement, once Novadaq has recovered aprescribed amount of revenue from a hospital for the use or purchase of a TMRlaser, any additional revenues earned by Novadaq are shared with us pursuant toa formula established in the distribution agreement. We only record our shareof such additional revenue, if any, at the time the revenue is earned.

 

Werecord all other product revenue, including sales of TMR lasers and kits tointernational customers, sales of RenalGuard consoles and single-use sets andOEM sales of surgical tubes and general purpose CO2 lasers, at the time of shipment.

 

Revenues from service andmaintenance contracts are recognized ratably over the life of the contract.

 

Installation revenuesrelated to a TMR laser transaction are recorded as a component of service feeswhen the laser is installed.

 

**Results of Operations**

 

Results for the three andnine months ended September 30, 2009 and 2008 and the related percent ofrevenues were as follows:

 
|                                       |   | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** |       |
|--------------------------------------------|--------|--------------------------------------------|------------|-------------------------------------------|------------|
|                                       |   | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** |   |
|                                       |   | **$**                                      | ** ** | **%**                                     | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** |   |
|                                       |   | **(dollars in thousands)**                 |       |
|                                       |   |                                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                             |   | $                                          | 1,023      |                                      | 100        | % | $ | 1,598 |   | 100 | % | $ | 3,810 |   | 100 | % | $ | 4,076 |   | 100 | % |
| Total cost of revenues                     |   | 500                                        |       | 49                                        |       | 829 |   | 52 |   | 1,575 |   | 41 |   | 1,807 |   | 44 |   |
| Gross profit                               |   | 523                                        |       | 51                                        |       | 769 |   | 48 |   | 2,235 |   | 59 |   | 2,269 |   | 56 |   |
| Selling, general & administrative |   | 702                                        |       | 69                                        |       | 619 |   | 39 |   | 2,667 |   | 70 |   | 2,420 |   | 59 |   |
| Research & development            |   | 180                                        |       | 17                                        |       | 516 |   | 32 |   | 594 |   | 16 |   | 1,726 |   | 42 |   |
| Total operating expenses                   |   | 882                                        |       | 86                                        |       | 1,135 |   | 71 |   | 3,261 |   | 86 |   | 4,146 |   | 102 |   |
| Loss from operations                       |   | (359                                       | )          | (35                                       | )          | (366 | ) | (23 | ) | (1,026 | ) | (27 | ) | (1,877 | ) | (46 | ) |
| Other income, net                          |   | 1                                          |       | —                                    |       | 11 |   | 1 |   | 3 |   | — |   | 89 |   | 2 |   |
| Loss before taxes                          |   | (358                                       | )          | (35                                       | )          | (355 | ) | (22 | ) | (1,023 | ) | (27 | ) | (1,788 | ) | (44 | ) |
| Benefit from income taxes                  |   | —                                     |       | —                                    |       | (70 | ) | (4 | ) | — |   | — |   | (70 | ) | (2 | ) |
| Net loss                                   |   | $                                          | (358       | )                                         | (35        | )% | $ | (285 | ) | (18 | )% | $ | (1,023 | ) | (27 | )% | $ | (1,718 | ) | (42 | )% |

 

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|                                                |   | **Three Months Ended  September 30,** | ** ** | **Increase (decrease)** | ** ** | **Nine Months Ended  September 30,** | ** ** | **Increase (decrease)** |       |
|-----------------------------------------------------|--------|--------------------------------------------|------------|-------------------------|------------|-------------------------------------------|------------|-------------------------|------------|
|                                                |   | **2009**                                   | ** ** | **2008**                | ** ** | **over 2008**                             | ** ** | **2009**                |       | **2008** | ** ** | **over 2008** |   |
|                                                |   | **$**                                      | ** ** | **$**                   | ** ** | **$**                                     | ** ** | **%**                   | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **%** |   |
|                                                |   | **(dollars in thousands)**                 |       |
|                                                |   |                                       |       |                    |       |                                      |       |                    |       |   |   |   |   |   |   |   |   |
| Product sales                                       |   | $                                          | 701        |                    | $          | 1,203                                     |       | $                       | (502       | ) | (42 | )% | $ | 2,824 |   | $ | 3,041 |   | $ | (217 | ) | (7 | )% |
| Service fees                                        |   | 322                                        |       | 395                     |       | (73                                       | )          | (18                     | )          | 986 |   | 1,035 |   | (49 | ) | (5 | ) |
| Total revenues                                      |   | 1,023                                      |       | 1,598                   |       | (575                                      | )          | (36                     | )          | 3,810 |   | 4,076 |   | (266 | ) | (7 | ) |
| Product cost of sales                               |   | 311                                        |       | 647                     |       | (336                                      | )          | (52                     | )          | 1,059 |   | 1,290 |   | (231 | ) | (18 | ) |
| Service fees cost of sales                          |   | 189                                        |       | 182                     |       | 7                                         |       | 4                       |       | 516 |   | 517 |   | (1 | ) | — |   |
| Total cost of revenues                              |   | 500                                        |       | 829                     |       | (329                                      | )          | (40                     | )          | 1,575 |   | 1,807 |   | (232 | ) | (13 | ) |
| Gross profit                                        |   | 523                                        |       | 769                     |       | (246                                      | )          | (32                     | )          | 2,235 |   | 2,269 |   | (34 | ) | (1 | ) |
| Selling, general & administrative expenses |   | 702                                        |       | 619                     |       | 83                                        |       | 13                      |       | 2,667 |   | 2,420 |   | 247 |   | 10 |   |
| Research & development expenses            |   | 180                                        |       | 516                     |       | (336                                      | )          | (65                     | )          | 594 |   | 1,726 |   | (1,132 | ) | (66 | ) |
| Total operating expenses                            |   | 882                                        |       | 1,135                   |       | (253                                      | )          | (22                     | )          | 3,261 |   | 4,146 |   | (885 | ) | (21 | ) |
| Loss from operations                                |   | (359                                       | )          | (366                    | )          | 7                                         |       | (2                      | )          | (1,026 | ) | (1,877 | ) | 851 |   | (45 | ) |
| Other income, net                                   |   | 1                                          |       | 11                      |       | (10                                       | )          | (91                     | )          | 3 |   | 89 |   | 86 |   | 97 |   |
| Loss before taxes                                   |   | (358                                       | )          | (355                    | )          | (3                                        | )          | 1                       |       | (1,023 | ) | (1,788 | ) | 765 |   | (43 | ) |
| Benefit from income taxes                           |   | —                                     |       | (70                     | )          | 70                                        |       | (100                    | )          | — |   | (70 | ) | 70 |   | (100 | ) |
| Net loss                                            |   | $                                          | (358       | )                       | $          |  (285                                | )          | $                       |  (73  | ) | (26 | )% | $ | (1,023 | ) | $ | (1,718 | ) | $ |  695 |   | (40 | )% |

 

***Product Sales***

 

Disposable TMR kitrevenues, the largest component of product sales in the three and nine monthsended September 30, 2009, decreased by $89,000, or 16%, and $142,000, or8%, respectively, as compared to the three and nine months endedSeptember 30, 2008.  In the threemonths ended September 30, 2009, the decrease was due to (1) a$73,000 decrease in domestic TMR kit revenues as a result of both a lowervolume of TMR kits sold and lower disposable revenue amortization and(2) a $16,000 decrease in international TMR kit revenues stemmingprimarily from a lower volume of kit shipments to international customers. Inthe nine months ended September 30, 2009, the decrease was due to(1) an $87,000 decrease in domestic TMR kit revenues as a result of alower volume of TMR kits sold, offset by an increase in disposable revenueamortization, and (2) a $55,000 decrease in international TMR kit revenuesstemming primarily from a lower volume of kit shipments to internationalcustomers.

 

TMR laser revenuesdecreased $411,000, or 100%, in the three months ended September 30, 2009as compared to the three months ended September 30, 2008 due to theabsence of any Heart Laser Systems shipments in the 2009 quarter.

 

TMR laser revenuesdecreased $491,000, or 67%, in the nine months ended September 30, 2009 ascompared to the nine months ended September 30, 2008.  Domestic TMR laser revenues decreased by$406,000 due to the absence of any domestic Heart Laser Systems shipmentsduring the 2009 period.  InternationalTMR laser revenues decreased $85,000 in the

 

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nine months endedSeptember 30, 2009 due to one less laser transaction in the 2009 period,as well as a decrease in other international TMR laser revenues of $26,000.

 

InternationalRenalGuard sales increased $107,000, or 151%, and $301,000, or 212%,respectively, in the three and nine months ended September 30, 2009 due toan increase in the number of RenalGuard consoles and single-use sets shipped tointernational distributors.

 

                Other product sales decreased $109,000, or 65%, inthe three months ended September 30, 2009 as compared to the three monthsended September 30, 2008.  This decrease is due to lower OEMmanufacturing contract assembly product revenues as customer orders andshipments of new general purpose CO2 lasers have declined significantly in 2009.This trend is likely to continue for the remainder of 2009.

 

Other product salesincreased $115,000, or 32%, in the nine months ended September 30, 2009 ascompared to the nine months ended September 30, 2008.  Internationalother product sales increased $302,000 as a result of the one-time sale ofcertain third party equipment we were required to supply along with theinternational Heart Laser System sale that we recorded as revenue in the firstquarter of 2009. OEM manufacturing contract assembly product revenues decreased$187,000 as a result of a decline in new general purpose CO2 laser orders and shipments.

 

                ***ServiceFee Revenues***

 

Service fees decreased$74,000, or 19%, in the three months ended September 30, 2009 as comparedto the three months ended September 30, 2008. Domestic service feesdecreased $58,000 and international service fees decreased $16,000, both as aresult of fewer billable service calls.

 

Service fees decreased$50,000, or 5%, in the nine months ended September 30, 2009 as compared tothe nine months ended September 30, 2008. Domestic service fees decreased$75,000 as a result of fewer billable service calls to domestic customers. Thisdecrease was offset in part by increased international service fees of $25,000.

 

***Gross Profit***

 

 Gross profit was$523,000, or 51% of total revenues, in the three months ended September 30,2009 as compared with gross profit of $769,000, or 48% of total revenues, inthe three months ended September 30, 2008. The decrease in gross profit dollars is due to (1) lower OEMmanufacturing contract assembly revenues and (2) lower TMR revenues andservice fees.  These decreases wereoffset in part by (1) the absence of a non-recurring inventory reservecharge recognized in the 2008 period and (2) higher internationalRenalGuard sales.

 

Gross profit was$2,235,000, or 59% of total revenues, in the nine months endedSeptember 30, 2009 as compared with gross profit of $2,269,000, or 56% oftotal revenues, in the nine months ended September 30, 2008. The decreasein gross profit dollars is due to (1) lower OEM manufacturing contractassembly revenues and (2) lower TMR disposable and service revenues.  These decreases were offset in part by(1) the international sale of a Heart Laser System and other third partyequipment in the first quarter and (2) an increase in internationalRenalGuard sales.

 

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***Selling, General and Administrative Expenses***

 

                Selling, general and administrative expendituresincreased 13% and 10%, respectively, in the three and nine months endedSeptember 30, 2009 as compared to the three and nine months endedSeptember 30, 2008.

 

                The increase in the three months endedSeptember 30, 2009 resulted primarily from a reversal of certain incentivecompensation related expense in the three months ended September 30, 2008that did not recur in the three months ended September 30, 2009.

 

The increase in the ninemonths ended September 30, 2009 was due to higher sales expensesassociated with the sale of the Heart Laser System and third party equipment wesupplied during the first quarter of 2009, which together totaled$269,000.  This increase was offset inpart by lower compensation-related costs, due to workforce reductions, andlower incentive compensation expense.

 

***Research and Development Expenses***

 

Research and developmentexpenditures decreased 65% and 66%, respectively, in the three and nine monthsended September 30, 2009 as compared to the three and nine months endedSeptember 30, 2008. These decreases were due to (1) lower RenalGuardclinical trial costs resulting from the deferral of the U.S. pivotal study and(2) reduced RenalGuard product development expenditures.

 

***Other Income***

 

Other income decreased$10,000, or 91%, and $86,000, or 97%, respectively, in the three and ninemonths ended September 30, 2009 as compared to the three and nine monthsended September 30, 2008.  This decrease in both periods is a resultof lower interest income due to lower average investable balances and lower interestrates on those investable balances.

 

***Net Loss***

 

In thethree months ended September 30, 2009, our net loss increased $73,000, or26%, compared to the three months ended September 30, 2008, due to(1) lower gross margin dollars, (2) the absence of a non-recurringbenefit for income taxes recorded in the 2008 period and (3) lower otherincome, offset in part by lower operating expenses.  In the nine months ended September 30,2009, our net loss decreased $695,000, or 40%, from that of the same period in2008, due to lower operating expenses. This decrease was offset in part by(1) lower other income, (2) the absence of a non-recurring benefitfor income taxes recorded in the 2008 period and (3) lower gross margindollars.

 

***TMR Kit Shipments***

 

                We generally view disposable TMR kit shipments to endusers as an important metric in evaluating our TMR business, although webelieve that specific short-term factors not indicative of long-term trends cansometimes affect shipments of disposable TMR kits in any given quarter.  Domestic TMR kit shipments referenced in thetable below relate to sales by Novadaq to hospital end users.  International TMR kit shipments relate tosales by us directly to our

 

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internationaldistributors or hospital end users.

 

DisposableTMR kit shipments to end users were as follows:

 
| ** **                      | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2009**                                    | ** ** | **2008**                                   | ** ** | **%  Decrease  Over  2008** | ** ** | **2009** | ** ** | **2008** | ** ** | **%  Decrease  Over  2008** | ** ** |
| Domestic  (by U.S. Distributor) |       | 218                                         |       | 398                                        |       | (45 | ) | 768 |   | 1,120 |   | (31 | ) |
| International                   |       | 5                                           |       | 11                                         |       | (55 | ) | 42 |   | 61 |   | (31 | ) |
| Total                           |       | 223                                         |       | 409                                        |       | (45 | ) | 810 |   | 1,181 |   | (31 | ) |

 

**Liquidityand Capital Resources**

 

Cashand cash equivalents totaled $3,252,000 as of September 30, 2009, adecrease of $1,774,000 from $5,026,000 as of December 31, 2008.  We have no debt obligations. We believe thatour existing cash resources will meet our working capital requirements for thenext 12 months; however, we are seeking to raise additional capital, which willbe needed to continue our operations and implement our RenalGuard businessplan, within the next 12 months.

 

Cashused for operating activities in the nine months ended September 30, 2009was $1,817,000 due to our net loss, partially offset by non-cash depreciationand amortization expense and non-cash compensation expense related to stockoptions.  The effect of exchange ratechanges was a $43,000 increase in cash.

 

In the near term, whilewe do not expect that our TMR-related revenues will change significantly, we dobelieve it is more likely they will decline over time. Therefore we will belargely dependent upon our ability to increase our revenues through the sale ofhigher volumes of our RenalGuard product into international markets. Shouldinternational sales of RenalGuard not increase sufficiently, our liquidity,capital resources and prospects for growth will be severely impacted.

 

              There can be no assurance that the capital we will needto continue our operations and implement our business plan will be available onterms and conditions acceptable to us. Should additional financing not be available on terms and conditionsacceptable to us, we will need to take actions that will adversely impact ourability to continue to realize assets and satisfy liabilities in the normalcourse of business.  The consolidatedfinancial statements set forth in this report do not include any adjustments toreflect the possible future effects of these uncertainties.

 

**Forward-LookingStatements**

 

This quarterly report onForm 10-Q contains forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended (the“Exchange Act”). Statements containing terms such as “believes”, “plans”,“expects”, “anticipates”, “intends”, “estimates” and similar expressionsreflect uncertainty and are forward-looking statements. Forward-looking statementsare based upon current plans and expectations and involve known and unknownimportant risks and uncertainties

 

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that could cause actualresults to differ materially from those described in the forward-lookingstatements. Such important factors and uncertainties include, but are notlimited to:

 

·                  We will need to, and we may be unable to,raise capital to continue our operations in the future, including to implementour RenalGuard business plan, and any such financing will likely be highlydilutive to existing shareholders given our current market capitalization;

·                  We expect to incur significant net lossesin future quarters, at least through 2010;

·                  We are currently dependent on oneprincipal product line, the Heart Laser System, and one principal customer,Novadaq, to generate revenues for us;

·                  We believe it is likely that our TMRrevenues will decline over time, making our future prospects highly dependentupon the successful commercialization of RenalGuard;

·                  If we are unable to raise additionalcapital, we will not be able to commence our U.S. pivotal clinical trial tostudy RenalGuard to determine if it is safe and effective in reducing theincidence rate of CIN. We therefore may never be successful in our goal ofdemonstrating the value of RenalGuard in the U.S. which would have an impact onthe overall valuation of the Company;

·                  Our ability to effectively marketRenalGuard outside the U.S. is largely dependent on obtaining favorable resultsfrom an investigator-sponsored clinical trial of RenalGuard currently underwayat the CCM; however, we have no assurance that the final results from the CCMtrial will be clinically significant or meaningful or that they will lead toincreased sales of RenalGuard;

·                  We may never be successful inestablishing a broad distribution channel for RenalGuard outside the U.S., andany distribution channel we may establish may never generate sufficient salesfor us to attain profitability;

·                  Our RenalGuard System has only hadlimited testing in a clinical setting and we may need to modify itsubstantially in the future for it to be commercially acceptable; and

·                  Any potential future modificationsrequired to make RenalGuard commercially acceptable may result in substantialadditional costs and/or market introduction delays.

 

**Off-BalanceSheet Arrangements**

 

None.

 

**Item 3.        Quantitative and Qualitative Disclosures about Market Risk**

 

Pursuantto Item 305(e) of Regulation S-K, we are not required to provide thisinformation because we are a smaller reporting company.

 

**Item 4T.  Controls andProcedures**

** **

***Evaluation of Disclosure Controls and Procedures***

 

                Our management, with the participation of our chiefexecutive officer and chief financial officer, evaluated the effectiveness ofour disclosure controls and procedures as of September 30, 2009.  The term “disclosure controls andprocedures”, as defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act, means controls and other procedures of a company that aredesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms. 

 

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Disclosure controls andprocedures include, without limitation, controls and procedures designed toensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, as appropriate to allow timely decisions regarding requireddisclosure.  Management recognizes thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving their objectives and managementnecessarily applies its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.  Basedupon the evaluation of our disclosure controls and procedures as ofSeptember 30, 2009, our chief executive officer and chief financialofficer concluded that, as of such date, our disclosure controls and procedureswere effective at the reasonable assurance level.

 

***Changes in Internal Control over Financial Reporting***

 

                No change in our internal control over financialreporting (as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) occurred during the fiscal quarter ended September 30, 2009that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**Part II.  Other Information**

 

**Item 1A.       Risk Factors**

 

                Pursuant to the instructions to Item 1A. ofForm 10-Q, we are not required to provide this information because we area smaller reporting company.

 

**Item 6.            Exhibits**

 
| **Exhibit  Number** | ** ** | **Description of Document**                                                                                                                                                                                               |                                                                                                                                                                                                                      |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                      |                                                                                                                                                                                                                      |
| 31.1                |       | Certification of  Principal Executive Officer pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                      |                                                                                                                                                                                                                      |
|                | 31.2       |                                                                                                                                                                                                                      | Certification of  Principal Financial Officer pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                                                                                      |                                                                                                                                                                                                                      |
|                | 32.1       |                                                                                                                                                                                                                      | Certifications  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                      |
|                     |            |                                                                                                                                                                                                                           |                                                                                                                                                                                                                           |  |  |  |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                          | PLC SYSTEMS INC. |
|-------------------------------|------------------|
|                          |             |   |
| Date: November 13,  2009 | By:              | /s/ James G.  Thomasch |
|                          |             | James G.  Thomasch |
|                          |             | Chief Financial  Officer  (Principal Financial Officer and Chief  Accounting Officer) |

 

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**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Description  of Document**                                                                                                                                                                                              |                                                                                                                                                                                                                      |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          |       |                                                                                                                                                                                                                      |                                                                                                                                                                                                                      |
| 31.1                |       | Certification of  Principal Executive Officer pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                      |                                                                                                                                                                                                                      |
|                | 31.2       |                                                                                                                                                                                                                      | Certification of  Principal Financial Officer pursuant to Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                                                                                      |                                                                                                                                                                                                                      |
|                | 32.1       |                                                                                                                                                                                                                      | Certifications  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                      |
|                     |            |                                                                                                                                                                                                                           |                                                                                                                                                                                                                           |  |  |  |

 

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